Perry Mehrling, Economics

October 16, 2009

This fall, Barnard Professor of Economics Perry Mehrling intended to kick off his year of academic leave by buckling down to work on his next book. But after Wall Street reached a crisis point in mid-September, he realized he'd have to postpone those plans.

After a series of speedily written blog posts, papers, and op-eds, he found himself working alongside Boston University economist Laurence Kotlikoff and members of the House of Representatives on the $700 billion bailout plan intended to save a faltering American banking system. It all happened in a whirlwind, but Mehrling says his years of experience teaching at Barnard prepared him to jump in and assist in the nation's biggest financial crisis in 80 years.

For the past decade Mehrling, who received his B.A. and Ph.D. from Harvard and a Master's degree from the London School of Economics, has taught an increasingly popular course called Economics of Money and Banking, which has helped him develop and refine a new theory of the monetary economy.

"All of the ideas I have developed [concerning the bailout] have come out of the course," he says. "For ten years, I've had the luxury of improving on and testing different theories in the classroom, figuring it out with the students."

Mehrling takes a "balance sheet" approach to the monetary economy that views all banking—from loans and mortgages to interest rates and currencies—as "a swap of IOUs." This monetary and financial system, organized as a hierarchy of credit, depends heavily on credit insurance, which is often issued in the form of a "credit default swap." The failure of the system of credit default swaps, Mehrling says, is at the heart of the problems our banking system faces today.

The gist of the plan he and Kotlikoff developed, called the KM plan, is the idea that the government, rather than buying the troubled assets of failing banks, should sell credit insurance to these institutions. This way, not only would the market be reactivated and the costs to taxpayers mitigated, but the banks would have to take into account the public costs of their private actions.

The KM plan first garnered attention from Republicans as the House worked toward a bailout plan in late September, eventually drawing support from both sides of the aisle. Section 102 of the bill that ultimately passed incorporates the essential parts of the KM plan. It provides for an insurance fund separate from the asset-purchasing fund, and includes a formula for calculating how much each insurance policy contributes toward the $700 billion total.

Mehrling doesn't usually spend his time in the world of partisan politics and policy details. "I'm a library person, I like ideas. I like being with my books and my students," he says. "I was very fortunate to be at the right place with the right students to be able to try these ideas out in a classroom, which laid the groundwork for bringing the ideas out into the public."

But being in the right place at the right time was not exactly an accident. Mehrling says a big part of his decision to come to Barnard, in 1987, was the school's proximity to the markets. "The beating heart of international capitalism resides in New York, and we're always just a subway ride away from the most sophisticated economic minds in the world," he says. This is also why he feels that he clicks with Barnard students, many of whom value having an intellectual understanding of the system in addition to an internship downtown. "I'm not interested in just training traders," he says.

Mehrling, who is the author of two books on the history of finance and monetary economics, Fischer Black and the Revolutionary Idea of Finance and The Money Interest and the Public Interest: American Monetary Thought, 1920-1970, was teaching intermediate macroeconomics when he realized how outdated the framework for teaching money and banking was. "It was very 1950s, which isn't how the world works anymore. We needed to start from a completely other place," he says. "The first year [he taught the newly conceived course, Economics of Money and Banking], I told the students, 'I don't really know where this is going, but we're going to figure it out together.'"

Instead of relying on a textbook, Mehrling instructs his students to read the Financial Times daily, and has taught them how to "read it like an expert," translating market jargon into plain English. He also uses other financial publications and documents to immerse his students in a kind of anthropology of the language and culture of the money markets. In this way students have the tools to learn how to learn about the economy, and are able to develop and maintain an expertise in the world of finance. For Mehrling, a self-described "Financial Times junkie," having the KM plan endorsed in the editorial pages of the FT was even better than having it included in the Paulson bailout bill.

Provided the markets permit some downtime, Mehrling intends to shape the compendium of lectures and course notes he's compiled over the years into a book aimed at a general readership. "People who are trying to figure out what is going on in the world, trying to understand the bailout, this book will help them with the intellectual foundation."

And now that the bill has passed, Mehrling knows the real work is just beginning. "Now in addition to educating Barnard and Columbia students, I feel an obligation to help educate the American public about these important issues. We as economists have a big job ahead of us, but I'm not worried." he says. "None of us knows where this is going, but we're going to figure it out together."